Elixir Securities Limited – Flash Note

Karachi, June 11, 2018 (PPI-OT): Pakistan Economy – PKR/USD Depreciation Marks a Paradigm Shift in Policy Making

Pak Rupee (PKR) has depreciated by 3.9% during the day to 121 against the greenback, from last week’s close of 116.5. Historically the local currency has depreciated in spurts, with today’s move being the third one during FY18TD (previous ones being in Dec-17 and Mar-18), taking the cumulative depreciation to 15% over the ongoing fiscal year (compared to flattish performance during FY15-17).

We see recent rounds of PKR depreciation as a paradigm shift in policy making since the end of Finance Minister Ishaq Dar’s era who remained rigid on maintaining fixed exchange rates. Lately, policy makers on both fiscal and monetary sides did not oppose currency depreciation as they saw it as a tool for addressing external account vulnerabilities.

The currency has continued to depreciate owing to growing pressures from deteriorating external account situation, and central bank allowing flexibility in exchange rates as a go-to tool to address this economic issue since structural policies would take long to bear fruits.

Based on this visible change in policy action, we believe that PKR’s implied fair value to policy makers would now be hinged on Real Effective Exchange Rate (REER) rather than Real Bilateral Exchange Rate (RBER) against USD due to structural inefficiencies (export uncompetitiveness and import inelasticity) translating into growing external account imbalances.

Note that after today’s move, we estimate that PKR is undervalued against USD on the basis of RBER, however we estimate it to be overvalued by 7% against USD based on REER.

We had so far been projecting PKR to reach 115 by Jun-18 and 120 by Dec-18; however the recent currency moves has overshot both our targets. Eyeing paradigm shift in policy making and continued pressures on external account, we project PKR/USD to depreciate by 7-12% to 130-135 by Jun-19 (FY19 end).

We estimate the said changes to raise our inflation forecasts by ~50bps and thus, we also revise our interest rate expectations up by ~50bps – taking Discount Rate to 8.0% by Dec-18 (shown in the table below).

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Elixir Securities Limited – Flash Note

Karachi, June 11, 2018 (PPI-OT): Pakistan Economy – PKR/USD Depreciation Marks a Paradigm Shift in Policy Making

Pak Rupee (PKR) has depreciated by 3.9% during the day to 121 against the greenback, from last week’s close of 116.5. Historically the local currency has depreciated in spurts, with today’s move being the third one during FY18TD (previous ones being in Dec-17 and Mar-18), taking the cumulative depreciation to 15% over the ongoing fiscal year (compared to flattish performance during FY15-17).

We see recent rounds of PKR depreciation as a paradigm shift in policy making since the end of Finance Minister Ishaq Dar’s era who remained rigid on maintaining fixed exchange rates. Lately, policy makers on both fiscal and monetary sides did not oppose currency depreciation as they saw it as a tool for addressing external account vulnerabilities.

The currency has continued to depreciate owing to growing pressures from deteriorating external account situation, and central bank allowing flexibility in exchange rates as a go-to tool to address this economic issue since structural policies would take long to bear fruits.

Based on this visible change in policy action, we believe that PKR’s implied fair value to policy makers would now be hinged on Real Effective Exchange Rate (REER) rather than Real Bilateral Exchange Rate (RBER) against USD due to structural inefficiencies (export uncompetitiveness and import inelasticity) translating into growing external account imbalances.

Note that after today’s move, we estimate that PKR is undervalued against USD on the basis of RBER, however we estimate it to be overvalued by 7% against USD based on REER.

We had so far been projecting PKR to reach 115 by Jun-18 and 120 by Dec-18; however the recent currency moves has overshot both our targets. Eyeing paradigm shift in policy making and continued pressures on external account, we project PKR/USD to depreciate by 7-12% to 130-135 by Jun-19 (FY19 end).

We estimate the said changes to raise our inflation forecasts by ~50bps and thus, we also revise our interest rate expectations up by ~50bps – taking Discount Rate to 8.0% by Dec-18 (shown in the table below).

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